<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to_______
Commission File No. 0-24425
KING PHARMACEUTICALS, INC.
(Exact name of Registrant as specified in its charter)
TENNESSEE 54-1684963
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
501 FIFTH STREET 37620
Bristol, TN
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (423) 989-8000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---- -----
CLASS OUTSTANDING SHARES AT NOVEMBER 1, 1998
----- --------------------------------------
COMMON 32,104,730
<PAGE> 2
KING PHARMACEUTICALS, INC.
INDEX
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)
<S> <C>
Condensed Consolidated Balance Sheets as of September 30, 1998
and December 31, 1997 2
Condensed Consolidated Statements of Operations for the Three Months
and Nine Months ended September 30, 1998 and 1997 3
Condensed Consolidated Statements of Cash Flows for the Nine Months ended
September 30, 1998 and 1997 4
Notes to Condensed Consolidated Financial Statements 5-9
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations 10-13
PART II - OTHER INFORMATION
Item 1: Legal Proceedings 14
Item 2: Changes in Securities and Use of Proceeds
Item 6: Exhibits and Reports on Form 8-K 15
Note: Items 3 through 5 are not applicable.
SIGNATURES 16
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
KING PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-----------------------------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,988 $ 69
Accounts receivable, net 37,869 8,561
Inventory, net 28,253 10,850
Deferred income taxes 2,013 2,013
Prepaid expenses and other assets 1,641 1,319
--------- ---------
Total current assets 72,764 22,812
--------- ---------
Property, plant and equipment, net 91,702 17,170
Intangible assets, net 119,334 62,783
Other assets 6,883 2,098
--------- ---------
Total assets $ 290,683 $ 104,863
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable $ -- $ 916
Current portion of long-term debt 8,243 8,084
Accounts payable 17,791 5,871
Accrued expenses 13,574 6,503
Income taxes payable 6,756 1,862
--------- ---------
Total current liabilities 46,364 23,236
--------- ---------
Long-term debt 143,257 48,289
Deferred income taxes 2,763 4,004
--------- ---------
Total liabilities 192,384 75,529
--------- ---------
Shareholders' equity:
Common shares no par value, 150,000,000 shares authorized,
32,000,000 and 28,000,000 shares issued and outstanding,
respectively 66,572 16,455
Retained earnings 32,323 14,550
Due from related party (596) (1,671)
--------- ---------
Total shareholders' equity 98,299 29,334
--------- ---------
Total liabilities and shareholders' equity $ 290,683 $ 104,863
========= =========
</TABLE>
See accompanying notes.
2
<PAGE> 4
KING PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1998 1997 1998 1997
--------- --------- -------- ---------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
REVENUES:
Net sales $ 48,089 $ 12,735 $ 108,047 $ 33,817
Development revenues -- -- 5,283 --
--------- --------- --------- ---------
Total revenues 48,089 12,735 113,330 33,817
--------- --------- --------- ---------
OPERATING COSTS AND EXPENSES:
Cost of sales 20,521 3,757 41,933 9,545
Selling, general and administrative 9,627 5,121 25,040 13,526
Depreciation and amortization 2,592 560 6,506 1,632
--------- --------- --------- ---------
Total operating costs and expenses 32,740 9,438 73,479 24,703
--------- --------- --------- ---------
OPERATING INCOME 15,349 3,297 39,851 9,114
OTHER (EXPENSES) INCOME:
Interest expense (3,579) (596) (10,729) (1,762)
Interest income 35 4 89 64
Other 5 35 31 (21)
--------- --------- --------- ---------
Total other (expenses) (3,539) (557) (10,609) (1,719)
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM 11,810 2,740 29,242 7,395
Income tax expense 4,500 1,090 11,183 2,839
--------- --------- --------- ---------
INCOME BEFORE EXTRAORDINARY 7,310 1,650 18,059 4,556
ITEM
Extraordinary item, net of income taxes -- -- (286) --
--------- --------- --------- ---------
NET INCOME $ 7,310 $ 1,650 $ 17,773 $ 4,556
========= ========= ========= =========
Basic and diluted income per common share:
Income before extraordinary item $ 0.23 $ 0.06 $ 0.61 $ 0.18
Extraordinary item -- -- (0.01) --
--------- --------- --------- ---------
Net income $ 0.23 $ 0.06 $ 0.60 $ 0.18
========= ========= ========= =========
</TABLE>
See accompanying notes.
3
<PAGE> 5
KING PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except share data)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
1998 1997
---------- ---------
(Unaudited)
<S> <C> <C>
Net cash (used in) provided by operating activities: $ (1,381) $ 5,301
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (77,753) (957)
Deposit on equipment -- (1,325)
Purchases of intangible assets (56,559) (30,406)
Other 35 203
--------- ---------
Net cash used in investing activities (134,277) (32,485)
--------- ---------
Cash flows from financing activities:
Proceeds from revolving line of credit 20,139 13,219
Payments on revolving line of credit (20,291) (10,937)
Payments due from related party 1,075 (462)
Payments on shareholders' notes receivable -- 2,093
Proceeds from short-term debt -- 1,325
Payments on short-term debt (360) --
Proceeds from long-term debt and capital lease obligations 175,596 15,924
Payments on long-term debt and capital lease obligations (81,213) (3,342)
Debt issuance costs (7,335) --
Proceeds from issuance of common stock, net 50,966 8,007
--------- ---------
Net cash provided by financing activities 138,577 25,827
--------- ---------
Increase (decrease) in cash and cash equivalents 2,919 (1,357)
Cash and cash equivalents, beginning of the period 69 1,392
--------- ---------
Cash and cash equivalents, end of the period $ 2,988 $ 35
========= =========
</TABLE>
See accompanying notes.
4
<PAGE> 6
KING PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998 AND 1997
(IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 1. GENERAL
The accompanying unaudited interim condensed consolidated financial statements
of King Pharmaceuticals, Inc. (the "Company") have been prepared by the Company
in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X, and accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of items
of a normal recurring nature) considered necessary for a fair presentation have
been included. Operating results for the nine months ended September 30, 1998
are not necessarily indicative of the results that may be expected for the year
ended December 31, 1998. The Company believes that the disclosures are adequate
to make the information presented not misleading.
These financial statements should be read in conjunction with the audited
consolidated financial statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations relating thereto included in the
Company's Registration Statement on Form S-1 declared effective on June 25,
1998.
Certain amounts in the 1997 financial statements have been reclassified to
conform to the current year presentation.
NOTE 2. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 requires public business
enterprises to adopt its provisions for fiscal years beginning after December
15, 1997, and to report certain information about operating segments in complete
sets of financial statements of the enterprise issued to shareholders. Segment
disclosures will also be required in interim financial statements beginning in
the second year of application. The Company is evaluating the provisions of SFAS
No. 131, but has not yet determined if additional disclosure will be required.
On June 15, 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133 is effective
for all fiscal quarters of all fiscal years beginning after June 15, 1999. SFAS
No. 133 requires that all derivative instruments be recorded on the balance
sheet at their fair value. Changes in the fair value of derivatives are recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative is designated as part of a hedge transaction and, if it is,
the type of hedge transaction. The Company anticipates that, due to its limited
use of derivative instruments, the adoption of SFAS No. 133 will not have a
significant effect on the Company's results of operations or its financial
position.
5
<PAGE> 7
NOTE 3. INCOME PER SHARE
The following table sets forth a reconciliation of the numerators and
denominators in computing income per share:
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------- --------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Basic and diluted income per share:
Net income..................................... $7,310 $1,650 $17,773 $4,556
Weighted average shares........................ 32,075,132 28,000,000 29,461,217 25,656,881
Basic and diluted income per share............. $ 0.23 $ 0.06 $ 0.60 $ 0.18
</TABLE>
Options to purchase common stock were excluded from the computation of diluted
earnings per share because the exercise price was greater than the average
market price of the common stock of $13.65 and $13.67 for the three and nine
months ended September 30, 1998, respectively. There were no outstanding options
for the three and nine months ended September 30, 1997.
NOTE 4. INVENTORY
Inventory consists of the following:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
----------- -----------
(Unaudited)
<S> <C> <C>
Finished goods........................... $17,382 $ 7,568
Work-in-process.......................... 3,999 494
Raw materials............................ 6,872 2,788
------- -------
$28,253 $10,850
</TABLE>
NOTE 5. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- -----------
(Unaudited)
<S> <C> <C>
Land........................................ $ 3,949 $ 319
Building and improvements................... 54,381 13,563
Machinery and equipment..................... 34,117 5,766
Construction in progress.................... 5,496 585
------- -------
97,943 20,233
Less accumulated depreciation............... (6,241) (3,063)
------- -------
$91,702 $17,170
======= =======
</TABLE>
NOTE 6. ACQUISITIONS/INTANGIBLE ASSETS
On February 27, 1998 the Company acquired the rights, titles and interest to
certain product lines, and production facilities, and assumed manufacturing
contracts for third parties from Warner-Lambert Company (the "Sterile Products
Acquisition"). The purchase price of $127,913, including assumed liabilities of
$2,913, was allocated to real estate and equipment based on fair values ($44,130
and $28,914, respectively) with the residual ($54,869) being allocated to
intangible assets and is being amortized over 5 to 40 years and 25 years,
respectively. The purchase price was financed under the Company's new Credit
Agreement (Note 9).
6
<PAGE> 8
On June 30, 1998 the Company acquired the Menest(R) product line from
SmithKline Beecham Corporation ("SKB") for $5.0 million.
The following unaudited pro forma summary presents the financial information as
if all the acquisitions made in 1997 and 1998 had occurred on January 1, 1997.
These pro forma results have been prepared for comparative purposes and do not
purport to be indicative of what would have occurred had the acquisition been
made on January 1, 1997, nor are they indicative of future results.
<TABLE>
<CAPTION>
For the Nine Months For The Nine Months
Ended September 30, 1998 Ended September 30, 1997
------------------------ ------------------------
<S> <C> <C>
Net revenues.......................... $125,064 $97,297
======== =======
Net income............................ $ 19,218 $ 4,858
======== =======
Net income per common share........... $ 0.65 $ 0.19
======== =======
</TABLE>
Intangible assets are as follows:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- -------------
(Unaudited)
<S> <C> <C>
Septra(R), Proloprim(R), Mantadil(R), Kemadrin(R).. $ 15,425 $ 15,425
Cortisporin(R) .................................... 23,694 23,694
Sterile Products .................................. 54,509 --
Neosporin(R) ...................................... 5,876 5,876
Viroptic(R) ....................................... 5,229 5,229
Nucofed(R)/Quibron(R) ............................. 7,301 7,301
Polysporin(R) ..................................... 3,783 3,783
Menest(R) ......................................... 5,000 --
Other ............................................. 3,377 3,017
--------- ---------
124,194 64,325
Less accumulated amortization ..................... (4,860) (1,542)
--------- ---------
$ 119,334 $ 62,783
========= =========
</TABLE>
NOTE 7. CONTINGENCIES
Except as described below, the Company has not been a party to significant
litigation or other legal proceedings.
Many distributors, marketers and manufacturers of anorexigenic drugs have been
subject to claims relating to the use of these drugs. The Company is a defendant
in 44 lawsuits which claim damages for personal injury arising from the
Company's production of the anorexigenic drug, phentermine, under contract for
SKB. Generally, the lawsuits allege that the defendants (1) misled users of the
products with respect to the dangers associated with them, (2) failed to
adequately test the products, and (3) knew or should have known about the
negative effects of the drugs, and should have informed the public about the
risks of such negative effects. The actions generally have been brought by
individuals in their own right and have been filed in various state and federal
jurisdictions throughout the United States. They seek, among other things,
compensatory and punitive damages and/or court supervised medical monitoring of
persons who have ingested the product. The Company expects to be named in
additional lawsuits related to the Company's production of the anorexigenic drug
under contract for SKB.
While the Company cannot predict the outcome of these suits, the Company
believes that the claims against it are without merit and intends to vigorously
pursue all defenses available to it. The Company is being indemnified in all
7
<PAGE> 9
of these suits by SKB for which it manufactured the anorexigenic product,
provided that neither the lawsuits nor the associated liabilities are based upon
the independent negligence or intentional acts of the Company, and intends to
submit a claim for all unreimbursed costs to its product liability insurance
carrier. However, in the event that SKB is unable to satisfy or fulfill its
obligations under the indemnity, the Company would have to defend the lawsuit
and be responsible for damages, if any, which are awarded against it or for
amounts in excess of the Company's product liability coverage.
NOTE 8. OTHER TRANSACTIONS
On June 15, 1998 the Company entered into an interest rate swap transaction
through June 2001 with a notional principal amount of $50.0 million whereby the
Company pays a fixed interest rate of 5.485% and receives a floating rate based
on 1-month LIBOR. On March 16, 1998 the Company entered into an interest rate
transaction through March 2001 with a notional principal amount of $50.0 million
whereby the Company pays a fixed rate of 5.52% and receives a floating rate
based on 1-month LIBOR. The Company entered into the swap agreements to hedge
against interest rate risk associated with the variable rate Tranche A and
Tranche B Term Loans under its Credit Agreement (defined below).
On June 25, 1998 the Securities and Exchange Commission declared effective the
Company's Registration Statement on Form S-1 (File No. 333-38753) (the
"Registration Statement") relating to the initial public offering ("IPO") of up
to 4,000,000 primary shares of common stock. The Company closed the sale of
4,000,000 shares of common stock at $14.00 per share on June 30, 1998. The net
proceeds to the Company from the sale of stock in the IPO after deducting
underwriting discounts and commissions and offering expenses were approximately
$48,753. In June the Company used $5,000 for the acquisition of Menest(R). In
July the Company utilized $36,619 of the net proceeds from the IPO to repay
indebtedness under the Company's Credit Agreement. The balance of $7,134 was
used for repayment of debt under the Company's revolving line of credit under
the Credit Agreement and for general corporate purposes including working
capital and any future acquisitions.
On July 27, 1998 the underwriters excercised the option to purchase additional
shares to cover over-allotments of shares. Pursuant to this option, the
underwriters purchased 214,730 additional shares of which 104,730 of the shares
were purchased from the Company and 110,000 shares purchased from certain
selling shareholders. The sale of the over-allotment provided the Company with
$1,067 of net proceeds after underwriting discounts, commissions, and offering
expenses. On July 31, 1998 the Company made a required prepayment under the
Credit Agreement paying down $732 of the Tranche A Term Loan, and $68 of the
Tranche B Term Loan, with $267 remaining for general corporate purposes. The
following table sets forth a reconciliation of the gross IPO proceeds to the net
IPO proceeds.
<TABLE>
<S> <C>
Gross IPO proceeds $57,466
Underwriters discounts and commissions 4,118
IPO expenses paid in 1998 2,382
IPO expenses paid in 1997 710
IPO expenses remaining in accrued expenses 139
Net equity provided from IPO $50,117
</TABLE>
8
<PAGE> 10
NOTE 9. LONG-TERM DEBT
On February 27, 1998 the Company entered into a $195.0 million credit agreement
("Credit Agreement"). The Company used the proceeds to finance the Sterile
Products acquisition (Note 6), and repay the $40.0 million term loan and
outstanding borrowing under its revolver as of February 27, 1998. The Credit
Agreement includes Tranche A Term Loans of $90.0 million with a maturity of
December 31, 2003 with a floating interest rate of either LIBOR plus 2.75% or an
alternative rate based on either prime or the fed funds rate plus 0.5%, plus an
applicable margin of 1.75%, Tranche B Term Loans of $85.0 million with a
maturity of December 31, 2005 with a floating interest rate of either LIBOR plus
3.25% or an alternative rate based on either LIBOR plus 2.75% or an alternative
rate based on either prime or the fed funds rate plus 0.5%, plus an applicable
margin of 1.75%, selected at the discretion of the Company, and a $20.0 million
revolving line of credit for working capital requirements with a maturity of
December 31, 2003 with a floating interest rate of either LIBOR plus 2.75% or an
alternative rate based on either prime or the fed funds rate plus 0.5% plus an
applicable margin of 1.75%. In connection with this Credit Agreement, debt
issuance costs of $7.2 million were incurred and are being amortized over the
term of the respective loans.
As a result of the early retirement of borrowing under the senior secured term
loan and senior secured revolver, debt issuance costs associated with this debt
of $461 ($287 net of tax) has been included as an extraordinary item in the
Condensed Consolidated Statements of Operations for the nine months
ended September 30, 1998.
The Credit Agreement requires the Company to maintain certain maximum leverage
and interest expense coverage ratios and minimum cash flow and net worth ratios.
All existing and acquired tangible and intangible assets of the Company
collateralize the Credit Agreement.
9
<PAGE> 11
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion contains certain forward-looking statements
which reflect management's current views of future events and operations. These
forward-looking statements involve certain significant risks and uncertainties,
and actual results may differ materially from the forward-looking statements.
Some important factors which may cause results to differ include: significant
leverage and debt service requirements of the Company, dependence on the
Company's ability to continue to acquire branded products, dependence on sales
of the Company's products, management of the Company's growth and integration of
its acquisitions. Other important factors that may cause actual results to
differ materially from the forward-looking statements are discussed in "Risk
Factors" and other sections of the Company's prospectus dated June 25, 1998,
which is on file with the Securities and Exchange Commission as part of the
Company's Registration Statement on Form S-1. The Company does not undertake to
publicly update or revise any of its forward-looking statements even if
experience or future changes show that the indicated results or events will not
be realized. The following presentation of management's discussion and analysis
of financial condition and results of operations should be read in conjunction
with the Company's unaudited consolidated financial statements and related notes
thereto.
OVERVIEW
The Company is a vertically integrated pharmaceutical company that
manufactures markets and sells branded and generic prescription pharmaceutical
products. The Company's strategy is to acquire branded pharmaceutical products
and increase their sales by focused promotion and marketing, as well as by
developing product line extensions and through product life cycle management.
The Company markets a variety of branded prescription products,
including a broad line of ophthalmic and other anti-infective products
(including Cortisporin(R), Neosporin(R) and Coly-Mycin(R) M, cardiovascular
products (Thalitone(R) and Procanbid(R)), proctology products (Anusol-HC(R) and
Proctocort(R)), and women's health products (Pitocin(R) and Menest(R)). The
Company also markets biological products, which include flu vaccine, tuberculin
tine tests, and other prescription pharmaceutical products.
Since December 1994, the Company has acquired 31 branded pharmaceutical
products, developed three products internally, divested one product and
introduced eight product line extensions. The Company acquired from Glaxo
Wellcome, Inc. ("Glaxo Wellcome") the Cortisporin(R) product line in March
1997 and the Viroptic(R) product line in May 1997. The Company acquired 6
additional branded products from Glaxo Wellcome, including Septra(R), and
exclusive licenses, free of royalty obligations, for the prescription
formulations of Neosporin(R) and Polysporin(R), in November 1997 (the
"Glaxo Acquisition").
In February 1998, the Company acquired from Warner-Lambert Company 15
branded pharmaceutical products, a sterile manufacturing facility located in
Rochester, Michigan and certain manufacturing contracts for third parties for
$125.0 million (the "Sterile Products Acquisition"). The purchase price was
financed through borrowings from a group of financial institutions (the "Credit
Agreement").
On June 30, 1998, the Company acquired the Menest(R) product line
from SmithKline Beecham Corporation ("SKB") for $5.0 million.
In late June 1998, the Company launched its new Cortisporin(R) TC
Otic line. Cortisporin(R) TC is a product line extension for the Company's
Cortisporin(R) Otic Suspension product.
In August 1998, the Company received approval by the FDA to reintroduce
Fluogen(R) (influenza virus vaccine, Trivalent, Types A & B), which was acquired
as part of the Sterile Products Acquisition and had been off the market since
1996. Fluogen is a seasonal product with most of its sales occurring in the
third and fourth quarters.
The Company's strategy is to continue to acquire branded pharmaceutical
products and to create value by leveraging its marketing, manufacturing and
product development capabilities. The Company expects that its strategy of
acquiring branded pharmaceutical products will increase its revenues as a result
of sales of such products and will increase gross margins. In general, margins
are higher on the Company's branded pharmaceutical products than on the
10
<PAGE> 12
Company's other products, making branded products attractive to the Company. As
soon as practicable after regulatory requirements are satisfied, the Company
expects that using its manufacturing capability to ultimately produce these
acquired pharmaceutical products will increase the Company's margins because the
cost of producing pharmaceutical products on its own is lower than the cost of
having these products manufactured by third parties. The Company may also be
required to raise funds through additional borrowings or the issuance of debt or
equity securities in order to finance additional branded product acquisitions
and to expand or remodel its manufacturing facilities.
The Company has a number of manufacturing contracts with a variety of
pharmaceutical and biotechnology companies expiring at various times within the
next five years. The Company intends to enter into additional manufacturing
contracts in cases where the Company identifies contracts that offer significant
volumes and attractive margins. The Company has not accepted or renewed
manufacturing contracts for third parties where the Company perceived
insignificant volumes or revenues. In accordance with its focus on branded
pharmaceutical products, the Company expects that, over time, its contract
manufacturing and generic pharmaceutical and companion animal health product
lines will become a smaller percentage of revenues.
The following summarizes approximate net revenues by product categories
(in thousands).
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ----------------------
1998 1997 1998 1997
----- ---- ---- ----
<S> <C> <C> <C> <C>
Branded pharmaceuticals.................. $39,359 $9,996 $ 85,130 $26,972
Generic pharmaceuticals.................. 72 762 279 1,039
Contract manufacturing................... 8,434 1,892 22,205 5,090
Companion animal health.................. 224 85 433 716
Development revenues..................... -- -- 5,283 --
------- ------ -------- -------
Total................................ $48,089 $12,735 $113,330 $33,817
======= ======= ======== =======
</TABLE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
Revenues
Net revenues increased $35.4 million, or 278.7%, to $48.1 million in
1998 from $12.7 million in 1997, due primarily to the acquisition of branded
products. The Glaxo Acquisition and Sterile Products Acquisition collectively
contributed $36.1 million in total revenues in 1998, including $9.9 million in
net revenues from Fluogen(R) sales.
Revenues from contract manufacturing increased $6.5 million, or 342.1%,
to $8.4 million in 1998 from $1.9 million in 1997, due primarily to the
increased contract manufacturing related to the Sterile Products Acquisition.
Operating Costs and Expenses
Total operating costs and expenses increased $23.3 million, or 247.9%,
to $32.7 million in 1998 from $9.4 million in 1997. The increase was due to
increases in the costs associated with the growth of the Company, particularly
the Sterile Products Acquisition.
Cost of sales increased $16.7 million, or 439.5%, to $20.5 million in
1998 from $3.8 million in 1997. The increase was due primarily to the costs
associated with the newly acquired branded product lines. In 1998, the
percentage increase in cost of sales was greater than the percentage increase in
net revenues due to the additional contract manufacturing related to the Sterile
Products Acquisition, which has lower gross margins than the branded products.
Additionally, the Fluogen(R) product line has margins significantly lower than
other branded product lines.
Selling, general and administrative expenses increased $4.5 million,
or 88.2%, to $9.6 million in 1998 from $5.1 million in 1997. This increase was
primarily attributable to the hiring of additional sales representatives
during the second half of 1997 and first part of 1998, as well as other
additional personnel costs and marketing, promotion and sampling costs
associated with the new branded product lines.
Depreciation and amortization expense increased $2.0 million, or
357.1%, to $2.6 million in 1998 from $560,000 in 1997. This increase was
primarily attributable to the depreciation and amortization of the fixed assets
and intangible assets acquired with the branded product acquisitions in 1997
and the Sterile Products Acquisition in 1998.
Operating Income
Operating income increased $12.0 million, or 363.6%, to %15.3 million
in 1998 from $3.3 million in 1997. This increase was primarily due to increased
revenues from the acquisition of branded products. As a percentage of net
revenues, operating income increased to 31.9% in 1998 from 25.9% in 1997.
Interest Expense
Interest expense increased $3.0 million, or 503.4%, to $3.6 million in
1998 from $596,000 in 1997, as a result of additional term loans used to
finance, in part, the acquisitions of branded products and Sterile Products
Acquisition.
Income Tax Expense
The effective tax rate in 1998 of 38.1% and 1997 of 39.8% was higher
than the federal statutory rate of 35% primarily due to state income taxes.
Net Income
Due to the factors set forth above, net income increased $5.6 million,
or 329.4%, to $7.3 million in 1998 from $1.7 million in 1997.
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
11
<PAGE> 13
Revenues
Total revenues increased $79.5 million, or 235.2%, to $113.3 million
in 1998 from $33.8 million in 1997, due primarily to the acquisition of branded
products. The Glaxo Acquisition and Sterile Products Acquisition collectively
contributed $73.6 million in net revenues in 1998, including $9.9 million in
net revenues from Fluogen(R) sales.
Revenues from contract manufacturing increased $17.1 million, or
335.3%, to $22.2 million in 1998 from $5.1 million in 1997, due primarily to the
increased contract manufacturing related to the Sterile Products Acquisition,
increases in revenues from two contracts at the Bristol facility and offset, in
part, by the expiration of a contract.
Additionally, the Company recognized $5.0 million in development
revenues as a result of the FDA approval and validation of the process by the
Company of two additional ANDA's pursuant to an agreement with Mallinckrodt.
Operating Costs and Expenses
Total operating costs and expenses increased $48.8 million, or 197.6%,
to $73.5 million in 1998 from $24.7 million in 1997. The increase was due to
increases in the costs associated with the growth of the Company, particularly
the Sterile Products Acquisition.
Cost of sales increased $32.4 million, or 341.1%, to $41.9 million in
1998 from $9.5 million in 1997. The increase was due primarily to the costs
associated with the newly acquired branded product lines. In 1998, the
percentage increase in cost of sales was greater than the percentage increase in
net revenues due to the additional contract manufacturing related to the Sterile
Products Acquisition, which has lower gross margins than the branded products.
Also, the Fluogen(R) product line has lower gross profit margins than the
Company's other branded product lines.
Selling, general and administrative expenses increased $11.5 million,
or 85.2%, to $25.0 million in 1998 from $13.5 million in 1997. This increase was
primarily attributable to the hiring of additional sales representatives during
1997 and in April 1998, other additional personnel costs, and marketing,
promotion and sampling costs associated with the new branded product lines.
Depreciation and amortization expense increased $4.9 million, or
306.3%, to $6.5 million in 1998 from $1.6 million in 1997. This increase was
primarily attributable to the depreciation and amortization of the intangibles
and fixed assets acquired with the branded products acquisitions in 1997 and the
Sterile Products Acquisition in 1998.
Operating Income
Operating income increased $30.8 million, or 338.5%, to $39.9 million
in 1998 from $9.1 million in 1997. This increase was primarily due to increased
revenues from the acquisition of branded products. As a percentage of net
revenues, operating income increased to 35.2% in 1998 from 26.9% in 1997.
Interest Expense
Interest expense increased $8.9 million, or 494.4%, to $10.7 million in
1998 from $1.8 million in 1997, as a result of additional term loans used to
finance, in part, the acquisitions of branded product and the Sterile Products
Acquisition.
Income Tax Expense
The effective tax rate in 1998 of 38.2% and 1997 of 38.4% was higher
than the federal statutory rate of 35% primarily due to state income taxes.
Net Income
Due to the factors set forth above, net income increased $13.2 million,
or 287.0%, to $17.8 million in 1998 from $4.6 million in 1997.
LIQUIDITY AND CAPITAL RESOURCES
General
The Company's liquidity requirements arise from debt service, working
capital requirements and funding acquisitions of branded products.
On February 27, 1998 the Company consummated the Sterile Products
Acquisition for $127.9 million, including assumed liabilities of $2.9 million,
which was financed with the Credit Agreement. The Company also used a portion of
the Credit Agreement to pay off approximately $50.0 million of long-term debt,
which was then outstanding, including the borrowings used for the Glaxo
Acquisition.
On June 25, 1998 the Company completed its initial public offering of
4,000,000 shares of common stock, raising approximately $48.8 million of equity,
net of underwriting discounts and other offering expenses. On July 27, 1998 the
underwriters exercised the option to purchase additional shares to cover
over-allotments of shares. Pursuant to this option, the underwriters purchased
214,730 additional shares with 104,730 of the shares purchased from the Company
and 110,000 shares purchased from selling shareholders. The sale of the
over-allotment provided the Company with approximately $1.1 million of net
proceeds after underwriting discounts, commissions, and offering expenses. The
Company used a portion of the net proceeds to repay approximately $37.4 million
of debt outstanding pursuant to the Credit Agreement in July 1998.
As of September 30, 1998 the Company had available approximately $14.0
million under its revolving line of credit, which allows for total borrowing of
up to $20.0 million.
Net cash used in operating activities was $1.4 million for the nine
months ended September 30, 1998. The Company's net cash used in operating
activities was primarily the result of $17.8 million in net income resulting
from the purchase of additional branded products and depreciation and
amortization of $6.5 million. The Company's net cash used in operating
activities was impacted by an increase in receivables and inventory of $29.3
million and $17.8 million, respectively. Additionally, the Company increased its
accounts payable, accrued expenses and income taxes by $23.9 million.
12
<PAGE> 14
Cash flows used in investing activities was $134.3 million due
principally to the Sterile Products Acquisition for $126.1 million including the
costs, fees and expenses, the Menest(R) acquisition for $5.0 million, and other
purchases of property and equipment.
Net cash provided by financing activities was $138.6 million, which was
a result of the net proceeds from the initial public offering, additional
amounts repaid from a related party and proceeds from long-term debt and capital
lease obligations, offset by payments on the revolving line of credit, debt
issuance costs and other borrowings.
As of September 30, 1998 the Company had outstanding approximately
$151.5 million of long-term debt (including current portion) including
borrowings under its revolving line of credit agreement and term loans. Of these
amounts, approximately $141.6 million were at variable rates based on LIBOR and
the remainder at fixed rates. The Company has entered into $100.0 million
interest rate swap hedging transactions with a commercial bank to exchange its
variable LIBOR for fixed rate interest. The Company does not believe its
exposure to changes in interest rates under its remaining variable rate
agreements will have a material effect on its financial condition or results of
operations. Certain financing arrangements require the Company to maintain
certain minimum net worth, debt to equity, cash flow and current ratio
requirements.
On February 27, 1998 the Company consummated the Sterile Products
Acquisition for $127.9 million, including assumed liabilities of $2.9 million.
The purchase price was financed under the Credit Agreement. The Company also
used a portion of the Credit Agreement to pay off approximately $48.2 million of
long-term debt, which was then outstanding. The Credit Agreement includes a
six-year $20.0 million revolving line of credit, a six year $90.0 million
amortizing Tranche A term loan facility and an eight-year $85.0 million
amortizing Tranche B term loan facility with customary covenants and with a
floating interest rate based on either LIBOR, the prime rate, or the fed funds
rate, plus an applicable margin, selected at the discretion of the Company.
The Company believes that existing credit facilities and cash expected
to be generated from operations are sufficient to finance its current operations
and working capital requirements. However, in the event the Company makes
significant future acquisitions, it may be required to raise funds through
additional borrowings or the issuance of additional debt or equity securities.
At present, the Company is actively pursuing the acquisition of additional
branded pharmaceutical products that may require the use of substantial capital
resources. There are, however, no present agreements or commitments with respect
to any such acquisitions.
Capital Expenditures
Capital expenditures, including capital lease obligations, were $77.8
million and $1.0 million for the nine months ended September 30, 1998 and 1997,
respectively. The principal capital expenditures included property and equipment
purchases in connection with the Sterile Products Acquisition. The Company is
anticipating total capital expenditures in 1998 to be approximately $81.0
million primarily to fund additional equipment purchases and building
improvements. As a result of the Sterile Products Acquisition, the Company
expects that it may need to incur additional capital expenditures over the next
few years in connection with the maintenance and operation of the Parkedale
facility. In addition, the Company expects to increase its capital expenditures
over the next few years as a part of its acquisition and growth strategy.
Year 2000 Compliance
The Company has conducted an evaluation of its information technology
and non-information technology computer systems with respect to the "Year 2000"
issue. This issue arises because many electronic systems use two digits rather
than four to determine dates. This could cause information technology systems
such as software applications, hardware, network systems and embedded systems to
misread important dates beginning in the year 2000, which could cause system
failures and disruption of operations.
Except for the Bristol facility which is currently being assessed, the
Company has completed a Year 2000 readiness assessment of its business
critical information technology and non-information technology systems. As a
result of the assessment, the Company is in the
process of developing and implementing corrective action plans designed to
address Year 2000 issues. These plans include modification, upgrade and
replacement of the Company's critical administrative, production and research
and development computer systems to make them Year 2000 ready. Implementation of
corrective action plans has begun.
Because the Company's operations depend on the uninterrupted flow of
materials and services from its contract manufacturers and other suppliers, the
Company's plans for Year 2000 readiness include receiving and analyzing
information from its suppliers with regard to their progress toward Year 2000
readiness. The Company intends to continue to monitor the progress of its key
suppliers toward Year 2000 readiness. The Company considers the most reasonably
likely worst case scenario is that one or more of the Company's suppliers
encounters a Year 2000 problem and is unable to supply materials. If this occurs
and the Company could not obtain the same materials from another vendor,
production could be interrupted, which could result in lost sales and profits.
In addition, while the Company is taking action to correct deficiencies in its
own systems, it is possible that one or more of the Company's facilities or
critical business systems might not achieve Year 2000 readiness as anticipated.
This could also result in disruption of operations and lost sales and profits.
The Company estimates that it will spend between $1.0 million and $1.5
million to become Year 2000 ready. The majority of this spending will constitute
replacement costs of non-compliant information technology systems and the
reprogramming of existing systems. It is possible that the actual cost of the
Company's Year 2000 readiness effort could exceed these estimates. Funds for
this project have come from the Company's cash flows and costs have been
expensed as incurred except for hardware, which has been capitalized.
13
<PAGE> 15
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Many distributors, marketers and manufacturers of anorexigenic drugs
have been subject to claims relating to the use of these drugs. The Company is a
defendant in 44 lawsuits which claim damages for personal injury arising from
the Company's production of the anorexigenic drug, phentermine, under contract
for SKB. Generally, the lawsuits allege that the defendants (1) misled users of
the products with respect to the dangers associated with them, (2) failed to
adequately test the products, and (3) knew or should have known about the
negative effects of the drugs, and should have informed the public about the
risks of such negative effects. The actions generally have been brought by
individuals in their own right and have been filed in various state and federal
jurisdictions throughout the United States. They seek, among other things,
compensatory and punitive damages and/or court supervised medical monitoring of
persons who have ingested the product. The Company expects to be named in
additional lawsuits related to the Company's production of the anorexigenic drug
under contract for SKB.
While the Company cannot predict the outcome of these suits, the
Company believes that the claims against it are without merit and intends to
vigorously pursue all defenses available to it. The Company is being indemnified
in all of these suits by SKB for which it manufactured the anorexigenic product,
provided that neither the lawsuits nor the associated liabilities are based upon
the independent negligence or intentional acts of the Company, and intends to
submit a claim for all unreimbursed costs to its product liability insurance
carrier. However, in the event that SKB is unable to satisfy or fulfill its
obligations under the indemnity, the Company would have to defend the lawsuit
and be responsible for damages, if any, which are awarded against it or for
amounts in excess of the Company's product liability coverage.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On July 27, 1998 the underwriters excercised the option to purchase
additional shares to cover over-allotments of shares. Pursuant to this option,
the underwriters purchased 214,730 additional shares of which 104,730 of the
shares were purchased from the Company and 110,000 shares purchased from certain
selling shareholders. The sale of the over-allotment provided the Company with
$1,067,000 of net proceeds after underwriting discounts, commissions, and
offering expenses. On July 31, 1998 the Company made a required prepayment under
the Credit Agreement paying down $732,000 of the Tranche A Term Loan, and
$68,000 of the Tranche B Term Loan, with $267,000 remaining for general
corporate purposes. In connection with the sale of the over-allotment the
Company paid $15,400 to Bourne & Co., Inc. for investment banking services.
14
<PAGE> 16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description
(27.1) Financial Data Schedule (For SEC Use Only)
(b) Reports on Form 8-K
None.
15
<PAGE> 17
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
KING PHARMACEUTICALS, INC.
Date: November 13, 1998 By: /s/ John M. Gregory
------------------------------------
John M. Gregory
Chairman and Chief Executive Officer
Date: November 13, 1998 By: /s/ Brian G. Shrader
------------------------------------
Brian G. Shrader
Chief Financial Officer
16
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